What is the 'ISLM Model'
The ISLM model, which stands for "investmentsavings, liquiditymoney," is a Keynesian macroeconomic model that shows how the market for economic goods (IS) interacts with the loanable funds market (LM) or money market. It is represented as a graph in which the IS and LM curve intersect to show the shortrun equilibrium between interest rates and output.
BREAKING DOWN 'ISLM Model'
British economist John Hicks first introduced the ISLM model in 1937, just one year after fellow British economist John Maynard Keynes published "The General Theory of Employment, Interest, and Money." Hick's model served as a formalized graphical representation of Keynes' theories, though it is used mainly as a heuristic device today.
The three critical exogenous variables in the ISLM model are liquidity, investment, and consumption. According to the theory, liquidity is determined by the size and velocity of the money supply. The levels of investing and consumption are determined by the marginal decisions of individual actors.
The ISLM graph examines the relationship between real output, or GDP, and nominal interest rates. The entire economy is boiled down to just two markets, output and money, and their respective supply and demand characteristics push the economy towards an equilibrium point. This is sometimes referred to as "the Keynesian Cross."
Characteristics of the ISLM Graph
In the ISLM graph, the IS curve slopes downward and to the right. This assumes the level of investment and consumption is negatively correlated with the interest rate but positively correlated with gross output. By contrast, the LM curve slopes upward, suggesting the quantity of money demanded is positively correlated with the interest rate and with increases in total spending, or income.
Gross domestic product (GDP), or (Y), is placed on the horizontal axis, increasing as it stretches to the right. The nominal interest rate, or (i or R), makes up the vertical axis. Multiple scenarios or points in time may be represented by adding additional IS and LM curves. In some versions of the graph, curves display limited convexity or concavity.
Limitations of the ISLM Model
Many economists, including many Keynesians, object to the ISLM model for its simplistic and unrealistic assumptions about the macroeconomy. In fact, Hicks later admitted model's flaws were fatal, and it was probably best used as "a classroom gadget, to be superseded, later on, by something better." Subsequent revisions have taken place for socalled "new" or "optimized" ISLM frameworks.
The model is a limited policy tool, as it cannot explain how tax or spending policies should be formulated with any specificity. This significantly limits its functional appeal. It has very little to say about inflation, rational expectations or international markets, although later models do attempt to incorporate these ideas. The model also ignores the formation of capital and labor productivity.

Microeconomic Pricing Model
A microeconomic pricing model is a model of the way prices are ... 
Growth Curve
A growth curve is a graphical representation of how a particular ... 
Change In Supply
A change in supply is a term used in economics to describe a ... 
Equity Curve
An equity curve is a graphical representation of the change in ... 
Curve Steepener Trade
Curve steepener trade is a strategy that uses derivatives to ... 
Supply Curve
A supply curve is a representation of the relationship between ...

Insights
Can Keynesian Economics Reduce BoomBust Cycles?
Learn about a British economist's proposed solution to a common economic problem. 
Investing
Interest Rates and Your Bond Investments
By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it. 
Investing
What is Deadweight Loss?
Deadweight loss can be applied to any deficiency caused by an inefficient allocation of resources. 
Insights
Understanding The Treasury Yield Curve Rates
Treasury yield curves are a leading indicator for the future state of the economy and interest rates. 
Trading
Giants Of Finance: John Maynard Keynes
This rock star of economics advocated government intervention at a time of freemarket thinking. 
Insights
Is a Recession in the Works? Ask an Inverted Yield Curve
An inverted yield curve has predicted the last seven recessions. Is number eight around the corner? 
Insights
Economist Guide: 5 Lessons John Maynard Keynes Teaches Us
Read about the paradoxical and confusing world of John Maynard Keynes, including the lessons modern economists can still learn from the British thinker. 
Insights
Examining The Phillips Curve
This model depicts an inverse relationship between unemployment and wage inflation, but is it accurate? 
Investing
More Model 3 Details Emerge on Tesla Earnings Call
Tesla said the Model 3 will have fewer "bells and whistles" but a more automated production process to enable scale.

What is the current yield curve and why is it important?
Understand what the current yield curve represents, and learn how market analysts commonly interpret various changes in the ... Read Answer >> 
Are there any exceptions to the law of demand in economics?
Read about some possible exceptions to the law of demand in microeconomics price charts, and learn why those exceptions do ... Read Answer >> 
What is the difference between financial forecasting and financial modeling?
Understand the difference between financial forecasting and financial modeling, and learn why a company should conduct both ... Read Answer >> 
How do I calculate the production possibility frontier in Excel?
Learn how to create production possibility frontier curves in Microsoft Excel and understand the importance of production ... Read Answer >> 
Are perfect competition models in economics useful?
Take a look at some of the arguments made by the proponents and critics of the theory of perfect competition in contemporary ... Read Answer >> 
How can I create a yield curve in Excel?
Understand how a yield curve depicts the term structures of interest rates,, discover how to measure U.S. Treasury bonds ... Read Answer >>